Q3 Market Performance

The major index returns for Q3 2008 are outlined below. Interestingly, the Russell 2000 was only down -1.74%, which compares favorably versus all other major U.S. indices and aggregate hedge fund performance based on the numbers we have been hearing.

Russell 2000 -1.74%Comp -9.24%DJIA -4.67%S&P500 -9.23%

Daryl G. JonesManaging Director

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10/01/08 03:19 PM EDT

LAND HO! LAND NO!

I wish I had a nickel for every time an investor brought up “hidden” assets as part of a long thesis on MGM MIRAGE. By hidden, of course, they mean land. I rarely see the same analysis for Boyd Gaming. Yet, BYD owns more developable land than MGM when viewed as a percent of enterprise value. As shown in the first chart, I calculate that the value of BYD’s land held for development comprises almost 20% of its enterprise value versus only 7% for MGM.

I’m certainly not advocating buying any stock for its land value right now. Land does have value that should be included in any valuation deep dive. The problem is that there is no market for land. I’m perfectly happy to argue that Las Vegas Strip acreage is worth $5 million or $10 million, but we don’t know until we actually see transactions at those levels. It is unlikely it’s worth $20 million per acre, as some analysts are still using in their target prices.

I’d put land value way down the last of why BYD looks interesting. More pertinent aspects of the thesis include liquidity, free cash flow, and the balance sheet. From a relative viewpoint, a land analysis is very instructive, however. Chart 2 compares BYD and MGM along 3 valuation metrics: EV/2009 EBITDA, (EV less land value)/EBITDA, and (EV less land and construction in progress)/EBITDA.

The beauty of this analysis is that it is relative and most of the land value for both BYD and MGM resides in Las Vegas (Strip and Locals). Any change in my assumptions for land value affects both companies. In these charts I value Strip land at $7.5m per acre, LV locals at $1m, and Atlantic City at $5m. I cannot defend these land valuations in a court of law. I only offer them up for comparison purposes.

The implications are clear. BYD is a much cheaper stock. You want to focus on land? Fine, BYD looks more attractive. Land is not important? OK. BYD looks more attractive.

MGM owns more developable land but BYD's is relatively more valuable

BYD is a lot cheaper no matter how you factor in land

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10/01/08 02:41 PM EDT

DPZ – International Remains strong and the U.S. looks to be Improving

Domino’s Pizza UK and Ireland, one of DPZ’s top 3 international master franchisees, reported strong 3Q sales trends today. Same-store sales grew 8.8%, which is an impressive number relative to last year’s comparison of up 14.1%. Domino’s UK and Ireland’s 535 stores account for about 15% of DPZ international store base. DPZ has relied on the success of its international business (represents over 25% of DPZ’s operating income) to offset recent domestic shortfalls. Going forward, the company expects a greater mix of its sales and income to stem from its international business as unit growth accelerates internationally. For reference, in 2008, DPZ continues to expect to add 200-250 net new stores despite its forecast of net negative 50-70 stores domestically.

Recent NPD trends indicate a sequential tick up in July QSR pizza category traffic. I would also expect August to have been helped by the Olympics. These two data points along with the fact that DPZ is facing an easier U.S. same-store sales comparison in 3Q (0.8% in 3Q07 vs. 4.4% in 2Q07) should benefit DPZ’s U.S. numbers. A pick up in 3Q U.S. trends would complement DPZ’s already proven international momentum.

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Dublin Down

Ireland’s ISEQ Financial index jumped 27.65% on Tuesday following the Irish government’s announcement that it will guarantee, in full, the deposits in the six Irish-owned banks and building societies, as well as their borrowings, for two years. Following the US Senate’s rejection of the $700bn bailout on Monday evening, it seemed that Irish stocks were likely to face another swan dive on Tuesday after Monday’s worst single-day performance in the ISEQ Index’s 25-year history. Anglo Irish Bank had lost 46% of its value on Monday, its biggest decline in two decades, largely as a result of the bailout of its German competitor Hypo Real Estate. Finance Minister Brian Lenihan felt compelled to act in the face of what he deemed “a huge liquidity famine” for the Irish economy.

While the move is attracting foreign deposits to Irish banks (cash is king), the move is certainly controversial. The government is effectively exposing the taxpayer to the collective liabilities of the six institutions – €400bn – while Irish GDP is approximately €190bn and the national debt stands is at €45bn. This constitutes a commitment of roughly 2x GDP. To put this in context, the proposed $700bn bailout in the United States amounts to 5% of U.S. GDP.

Mr. Lenihan insists that the government is not in the business of bailouts and will be charging the banks for the guarantee. The concentration of risk that the government is placing in the banking sector is massive and, as a result, raises questions about the viability of the economy. As a long-standing member of the European Union, Ireland’s guarantee has sent ripples throughout Europe. The scheme is said to give Irish banks an unfair advantage over foreign competitors. Furthermore, the fact that the guarantee applies to branches within Northern Ireland and Britain could enhance the perceived advantage. Authorities in Brussels are investigating whether or not the guarantee constituted illegal state aid.

Rory Green Analyst

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10/01/08 12:47 PM EDT

VOLATILITY: PUT/CALL RATIOS

Sometimes volatility has a directional bias.

Years ago when I was just starting out in the business I worked as part of a proprietary equity derivative group at a midsized investment bank. One of the market sentiment indicators that some of the old timers in the group followed were the difference between the put/call ratios for options individual equities and Indices. The theory was that Index options were primarily used as hedging instruments by large institutions while individual equity options better reflected the hedging and speculation of smaller investors –thus any divergence between the two ratios, particularly on a day with a major directional market move, was seen as a divergence in sentiment between big investors and the rest of us. During yesterday’s rally the put/call ratio for all index options cleared by the OCC exceeded the same ratio for individual equities by 83%. That is the only time that put buyers in the index market have outpaced put buyers in the single stock market by more than 60% on a day in which the S&P was up over 1% so far this year. Obviously the put/call ratios are currently skewed by the net-short ban on financial stocks but it’s still interesting to note that in the face of a 4.3% rally in the S&P 500 the put/call ratio for indices was so heavily skewed negative.

Andrew BarberDirector

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10/01/08 10:48 AM EDT

Primary Insights– BKC Sales Trends

Based on our “primary insights,” or “grass roots” proprietary research, which included a survey of various Burger King restaurant managers/employees, BKC’s U.S. solid top-line trends appear to have continued in September. Fifty percent of the respondents said they are experiencing better sales trends in September relative to August. About 33% of the restaurants surveyed said trends are stable with the month prior while 17% said sales have slowed sequentially. The two most cited drivers of improved trends were increased coupons/promotions and improved customer service. The former reason is somewhat concerning as same-store sales grew 5.5% at BKC’s U.S. and Canada segment in 4Q08, but margins still declined 230 bps (net of the reimaging program). Please refer to my post from September 28 for more “primary insights” details regarding recent discounting at BKC. Stable to slowing sales trends were attributed primarily to kids returning to school/vacation is over and the slowing economy.

BKC does not provide monthly sales data so we don’t know what trends were in August, but on its August 21 earnings call, management stated that July was a positive month and that it was confident BKC will continue to deliver quarterly consecutive positive comp performance throughout FY09. Management also stated that in 1Q09, however, the company is lapping 1Q08’s U.S. comparable sales growth of 6.8% (U.S. and Canada up 6.6%), its best quarter since the beginning of BKC’s turnaround in 2004. On average, the restaurants surveyed are seeing a 4.4% lift in same-store sales in September, which is somewhat slowed from the past two quarters of 5%-plus growth, but still a strong number relative to the comparison from 1Q08.

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